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Pengana Private Equity Trust - Secondary Offer Review (ASX code: PE1)

SECONDARY OFFER OVERVIEW

On 23 October 2019, Pengana Capital Group Limited (ASX: PCG) announced its intention to
offer additional units in the Pengana Private Equity Trust (ASX: PE1) in the first quarter 2020
period (‘Secondary Offer’). The rationale of the Secondary Offer was to satisfy strong latent
and realised secondary demand as well as improve the degree of secondary market liquidity
in the Trust. The Secondary Offer comprises an offer of up to 345.4m units at a subscription
price equal to $1.37 (representing the NAV per unit of the Trust as at 31 January 2020 less a
special distribution of $0.0125 per unit). The Secondary Offer comprises three components
based on a waterfall structure: 1) the 2:1 entitlement offer; 2) the shortfall offer; and, 3) the
discretionary offer. Under the entitlement offer, each existing investor as at the entitlement
record date of 20 February 2020 (“existing unitholders”) can subscribe for up to 2 new units
for every 1 unit held. The shortfall offer will include any new units not applied for under the
entitlement offer and is open to existing unitholders who have subscribed for their full 2:1
entitlement. The discretionary offer is open to existing unitholders and new investors, the
latter at the discretion of the Responsible Entity. Any new units that are not applied for under
the shortfall offer, plus 16.8m units under the Trust’s 15% placement capacity (of which ~10%
is being used for the discretionary offer with the remaining ~5% reserved for the future
issue of the loyalty units) will form part of the discretionary offer. All existing unitholders,
irrespective of whether participate in the 2:1 offer or not, will also receive loyalty units in PE1
issued at the subscription price and which will be fully paid for by PCG. The amount issued
to each existing unitholder will be based on 1) the units held and retained for four months
(expected to be 23 July 2020 and 2) a “loyalty percentage”, which will be equal to 1% per
$100 million raised under the offer. For example, if $100 million is raised under the offer, then
the loyalty percentage will be 1%. If $250 million is raised under the offer, then the loyalty
percentage will be 2.5%, etc. The variable percentage does not necessarily mean existing
unitholders are better off the higher the raise amount, all things being equal. Rather it is
designed to at least partly offset the increasing cash dilution impact the higher the secondary
offer raise amount.
SECONDARY OFFER CONCLUSION
The issue with any follow on capital raises in private investment markets is the risk of cash
dilution for existing unitholders. That is, it takes time to fully invest the new capital raised,
with the prolongation of this deployment timeline diluting the prior expected returns profile.
PCG have been steadfast in saying that it would only consider a secondary raise if it was
not detrimental to existing unitholders in addition to not providing a substandard returns
outcome to new investors (i.e. both should be on roughly the same footing in terms of longer
term expected returns). PCG have achieved this outcome for existing unitholders through a
unique structuring innovation in the Australian listed managed investments sector. Namely,
loyalty units are issued to all existing unitholders irrespective of whether they participate in
the 2:1 offer or not. This is in contrast to the recent Magellan and VGI Partners loyalty unit
offers, which required existing investors to participate in the respective offers. IIR has in
the past expressed reservations about this latter structure, with the risk that it creates an
incentive to participate in a raise based on considerations that are not entirely directly related
to the relevant investment vehicle. Hypothetically, if this sort of structure is determined to
partly create an incentive exogenous to the investment merits of the vehicle in question, IIR
suspects ASIC would ultimately review the appropriateness of the structure. Reassuringly,
the Responsible Entity and Investment Investment Manager has undertaken extensive
modelling on the basis of a maximum 2:1 raise to determine over a nine year forecast period
whether the additional capital raising will prejudice existing and new investors via its impact
on both the deployment of capital and investment returns when compared to the Investment
Investment Manager’s initial IPO expectations. This analysis reveals that both existing and
new investors are better offer under the 2:1. Existing investors, irrespective of whether they
participate in the 2:1 or not, are better off on account of the faster than initially expected
deployment of capital, the additional value of the loyalty units as well as the better than
modelled short duration credit returns. Expected annualised returns for new investors are
effectively comparable to existing IPO investors, as new investors are benefitting from a Day
1 portfolio that is already partially deployed into private equity. In our view, the structuring
of the loyalty units tied with the modelling initiative and output lead us to believe that the
secondary raise could not be better structured.